Chipotle Mexican Grill Inc

NYSE:CMG

Earnings Call Transcript 2018-Q3

[Operator]

Good afternoon, ladies and gentlemen. And welcome to the Chipotle Q3 2018 Earnings Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded.

I would now like to turn the conference over to Coralie Witter. Please go ahead.

[Coralie Tournier Witter, Chipotle Mexican Grill, Inc.]

Hi, everyone, and welcome to our call today. By now, you should have access to our earnings announcement released this afternoon for the third quarter of 2018. It may also be found on our Investor Relations website, at ir.chipotle.com.

Before we begin our presentation, I will remind everyone that parts of our discussion today will include forward-looking statements as defined in the Securities laws. These forward-looking statements will include statements regarding our outlook for the fourth quarter, the potential of a number of our digital sales strategies, sales trends and forecasts for future comparable sales; expected new restaurant openings; estimates of future food, labor, marketing, and maintenance and repair costs, and G&A spend; statements about our expected effective tax rates, and projections of the amount and timing of transformation and restructuring costs and stock repurchases, as well as other statements of our expectations and plans. These statements are based on information available to us today, and we are not assuming any obligation to update them.

Forward-looking statements are subject to risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements. We refer you to the risk factors in our Annual Report on Form 10-K, as updated in our subsequent Form 10-Qs for discussion of these risks.

Our discussion today will also include non-GAAP financial measures, reconciliations of which can be found on the presentation page of the Investor Relations section of our website, which can be found at the link included on the Presentations page.

I'd also like to remind everyone that we have adopted a self-imposed quiet period, restricting communications with investors during that period. The quiet period will begin on the 16th day of the last month of each fiscal quarter and continues until the next earnings conference call. For the fourth quarter of 2018, it will begin December 16, and continue through our fourth quarter earnings release.

We will start today's call with some prepared remarks from Brian Niccol, Chief Executive Officer; and Jack Hartung, Chief Financial Officer, after which we will take questions. Our entire executive leadership team is available during the Q&A period.

And now, I will turn the call over to Brian Niccol.

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Thanks, Coralie, and good afternoon, everyone. I'm pleased to report our third quarter results, which demonstrated that our strategies to win today and cultivate a better future are working.

Total overall sales grew 8.6% to $1.2 billion, driven by comparable restaurant sales increases of 4.4%, and 28 new restaurants opened in the quarter. The positive comp sales trends enabled us to expand restaurant level margin, which were up 260 basis points year-over-year, to 18.7%. Earnings per share adjusted for unusual cost grew 62%, to $2.16, and our GAAP earnings were $1.36. While the quarter experienced some sales headwinds, we had a noticeable lift in sales with the launch of our new 'For Real' marketing campaign in late September. And that increase has sustained through October. Marketing that drives culture, drives difference, and drives purchase combined with great operations, drives results.

Additionally in Q3, key growth initiatives moved forward at a healthy pace. And the team executed with excellence the relocation, the restructuring, the hiring of new talent, and our All Managers' Conference. We exited the quarter with momentum, which sets us up for a solid fourth quarter. And we remain focused on building a culture of innovation and great execution that will drive sustainable long-term growth.

Before I dive deeper into this quarter's bright spots, I'd like to take a step back to remind you that our strategy to win today and cultivate the future is based on five focus areas: one, becoming a more culturally relevant and engaging brand that builds love and loyalty; two, digitizing and modernizing our restaurant experience to create a more convenient and enjoyable guest experience; three, running great restaurants with great hospitality and throughput; four, being disciplined and focused to enhance our powerful economic model; and five, building a great culture that can innovate and execute across digital, access, menu, and the restaurant experience.

This quarter, we made strides towards becoming a more culturally relevant and engaging brand. Our 'For Real' campaign celebrates what is uniquely Chipotle, that our food reflects our belief that there is a connection between how food is raised and prepared and how it tastes. Real flavors, real ingredients, and real cooking techniques result in food that simply tastes better.

We are making much better use of our advertising budget by more effectively communicating who we are and by being in better communication channels, thereby increasing our resonance and visibility. We'll continue to be present on national TV through the middle of November, and the 'For Real' messaging will remain visible in digital and social channels for the balance of the year. Going forward, you can expect Chipotle to have a presence in national media where and when it makes sense and to have an always-on social and digital program.

While we are a brand that speaks to everyone, our consumer research tells us that we are particularly relevant to millennials and Gen Z consumers who share our values. And our customers also want to be our employees. During September, we hosted our All Managers' Conference and it was clear from looking at our general managers and field leaders in the audience, that they reflect our customer base. Our teams came away from this conference energized around our purpose, our values, and our goals, and ready to get back to their restaurants armed with inspiration and information on how to improve the hiring experience, the training experience, and the guest experience.

In Q3, we made progress on our purpose of cultivating a better world with the announcement of a new accelerator program called the Chipotle Aluminaries Project. This is funded by our Chipotle Cultivate Foundation to help food-focused growth stage ventures that share our belief of cultivating a better world and are seeking to disrupt the current food landscape and take their business to the next level. We are using insights from our consumer research to refine our innovation pipeline and how we communicate with our guests. We continue to hear that the number one reason that consumers eat elsewhere is because they don't have convenient access to Chipotle.

Expanding the reach of our digital system remains a key priority in providing our guests with easier access and greater convenience. The digitized second make lines are now in nearly 750 restaurants, and continue to be on track to be in all restaurants by the end of next year. The digital pick-up shelves are now in nearly 350 restaurants, and we are moving quickly to get them in all our restaurants before the middle of 2019. We continued to build momentum in digital this quarter, with digital sales growing 48%, accelerating from the year-over-year growth rates we saw in the first half of this year, and now accounting for 11.2% of sales.

App downloads have increased 25% since last quarter, and we are seeing strong interest from new and infrequent customers as well as frequent customers. As was the case last quarter, we are seeing particularly strong momentum from delivery. In Q2, we added DoorDash as a new partner, and in Q3, we added delivery capabilities directly from our app and website. A free delivery promotion from our app in September drove an acceleration in delivery sales in the quarter. We continue to see good incrementality in delivery and we see very little customer overlap between our in-app delivery and our third-party delivery partner app. We are pleased with how delivery in our app is attracting and retaining new and lapsed customers, and the results we're seeing across our delivery channel has validated our strategy to be available wherever and however our guests want to access us.

As we continue to remove friction from the digital ordering and pick-up process, we would expect our delivery time advantage to continue to widen. Our current average delivery time is under 30 minutes, already making us one of the most attractive choices for customers on our delivery partners' website, and this will keep getting better. As part of our goal to increase access, we are also exploring new formats that leverage digitally-enabled convenient. We're pleased with the early results from our initial digital pick-up lane restaurants and we will expand this test to additional new restaurants in 2019 across several markets. These restaurants have a convenient drive-up window for guests to pick-up digital orders. It's clear from these tests that our guests appreciate the added convenience as these restaurants generate digital sales that are far above our national average. This format is also a win for operations, as the window leverages our digital make-line.

We're also excited about our loyalty test, which launched in September in three test markets. It's very early, but sign-ups look promising, and we'll evaluate and learn from the loyalty test as it moves through the stage-gates in preparation for national launch during 2019. We also have a number of menu items going through our new stage-gate process so that we can build a pipeline for future years. We're testing quesadillas, nachos, bacon, lemonade and a Mexican chocolate milkshake for example. These items are in different phases of the stage-gate process. Importantly, we're improving our ability to deliver great innovations for our customers and restaurant teams with a new concept screening process, more consumer insight, and a better cross-functional process from idea to launch.

Lastly, I'd like to touch on where we are in our organizational transformation. At our all-managers conference last month, we rolled out our new values. These are, One, the line is the moment of truth. Two, teach and taste Chipotle. Three, authenticity lives here. And four, the movement is real. These values were very well received at the conference by our restaurant managers who are more energized than ever. We also emphasized the following key areas for operations to focus on going forward. Number one, throughput excellence, number two, team stability and development, number three, great tasting food, and number four, great customer hospitality. We did a number of store visits following the conference and asked our restaurant managers what they took away. I'm happy to say we are aligned from the support center to each individual restaurant. These values and focus areas also form the foundation for the culture we are building in our support centers, which exist to serve our general managers and team members so that they can delight our guests. I'm pleased with the significant progress we've made in rebuilding Chipotle into an organization with an inclusive culture that sets us up to be more innovative, more connected to what our guests want, and better at executing, so that we can capitalize on the tremendous growth opportunities in front of us. I'm delighted with the great talent that we're attracting, as well as the talent that we relocated.

We've continued to enhance our leadership team, adding Roger Theodoredis as General Counsel, who joins us from WhiteWave. The restructuring and the relocations are nearing completion, and we are building an organization with best-in-class and diverse talent. I love the start-up energy that greets me every day I come in.

Finally, before I turn it over to Jack, I want to thank all of our team members across the company that are providing our guests with a great experience, serving real food cooked to perfection and prepared in our restaurants with fresh ingredients. I'd also like to thank our general managers, who collectively did a great job managing the restaurant P&Ls during quarter three, enabling Chipotle to deliver on financial commitment.

Okay. Over to you, Jack.

[John R. Hartung, Chipotle Mexican Grill, Inc.]

Thanks, Brian. I'm equally pleased with how our team rose to the occasion and didn't miss a beat, despite managing a significant restructuring, to deliver a solid quarter and create sales momentum that has carried into the fourth quarter.

We generated revenue of $1.2 billion during the quarter, an increase of 8.6% from last year, and comp sales growth of 4.4%. Restaurant level margins of 18.7% expanded 260 basis points from last year, contributing to underlying earnings per share, adjusted for unusual items up 62%, to $2.16. The third quarter had unusual expenses, mostly related to the transformation. And that negatively impacted our tax rate and our earnings per share by about $0.80, leading to GAAP earnings per share of $1.36. As discussed last quarter, we'll continue to see costs over the next two quarters associated with our restructuring, relocation, and underperforming store closures.

In Q3, we recognized $26 million in total charges, with $10 million related to underperforming or closed restaurant, and $16 million related to the organizational restructuring and other unusual expenses. As a result of the transformation, as well as non-cash tax items, our reported effective tax rate increased to 36.8%, or about 690 basis points higher than our underlying effective tax rate of 29.9%, which I'll explain later. The Q3 comp of 4.4% was primarily driven by a higher-average tax on the price increase taken last November and January. And to a lesser extent, the addition of queso to our menu.

During the quarter, comps were in the mid-single digits during July and August, before softening to low-single digits in September, when we compare to the advertised launch of queso in 2017. With the launch of our 'For Real' campaign, with national TV in late September, comps moved back up and are running 4% so far in October.

Looking to Q4, we'll lap the price increase in about 1,000 restaurants in November, which will be a headwind to our overall Q4 comp by about 100 basis points. We would typically provide a first glimpse of our comp guidance for 2019 right now. But with the growing pipeline of initiatives still early on in a stage-gate process, we'll hold off in providing 2019 comp guidance until we have a better perspective of the timing and expected impact of each of these initiatives.

We opened 28 new restaurants in the quarter, and continue to expect to be at the lower end of our 130 to 150 new openings guidance for the full year. Our new restaurants this year have opened at stronger levels, and we continue to emphasize high-quality, high-returning new restaurants as we build out the pipeline. As a result of these strong unit economics, combined with a healthy pipeline for next year's openings, we expect to open between 140 to 155 new restaurants in 2019. As mentioned on our last call, we expect to close between 55 and 65 underperforming restaurants. In the third quarter we closed 32 of these restaurants, and 38 in total, including the six closed in Q2, all related to the restructuring. The remaining underperforming restaurants will close over the next several quarters, as we pursue strategic alternatives to manage our future rent liability.

Food costs for the quarter were 33.4%, a decrease of 160 basis points from the 35% in Q3 of last year. The decrease from last year was driven by the menu price increase, as well as more favorable avocado prices. These were offset by elevated prices for beef and paper and packaging items. We expect to be in the low 33% range in Q4, with the slight decrease from Q3 due to the shift in the supply of avocados back to Mexico, Peru, and Chile.

Labor costs for the quarter were 27.2%, or flat compared to Q3 of last year. The price increase offset wage inflation of about 4% to 5%. We also decreased our worker's comp liability by about $4 million in the quarter, due to better management of claims activity so far this year. We expect labor costs to increase to the mid 28% range in Q4, as a result of deleverage from seasonally-lower sales, as well as continued wage pressure.

Occupancy costs for the quarter were 7.1%, a decrease of 30 basis points from Q3 last year, and that's due mostly to the increase in comp sales. Other operating costs for the quarter were 13.7%, a decrease of 70 basis points from Q3 of last year. Our marketing and promo costs were 2.5% in the quarter, a decrease of about 70 basis points compared to Q3 of last year. The lower-than-expected marketing in Q3 is due to a timing shift into Q4 as our 'For Real' campaign began in late September and will continue through mid-November.

As a result, we expect marketing and promo cost will be in the low 4% of sales during Q4, while full-year marketing and promo will still be right around 3% of sales overall for the year. Other operating costs continue to include about 30 basis points of higher maintenance and repair costs, which we first discussed on the Q4 2017 call, and we expect M&R to continue at this elevated level for the rest of the year before abating in 2019.

SG&A in the quarter increased $24 million compared to Q2 of this year, the increase compared to last quarter was primarily due to $16 million in charges related to the restructuring and other unusual charges in the quarter, as well as $11 million for our biennial all-manager conference. Compared to Q3 of last year, the items I just listed mostly offset the one-time charge we had in the same quarter of last year.

Underlying G&A increased compared to last year, primarily in support of our restaurant growth and digitizing our restaurant experience and operational leadership changes in the field. For Q4, we expect total G&A to be right around $95 million, which includes an estimated $10 million to $12 million of restructuring related expenses. Underlying G&A in Q4, excluding bonuses and stock comp, is expected to be at similar levels as Q2 and Q3 of this year, however, both bonuses and stock comp are expected to be higher year-over-year as a result of better performance.

Depreciation for the quarter was 4.3%, an increase of 60 basis points from the 3.7% in Q3 of last year. This increase is due to the accelerated depreciation for the restaurant closures we discussed earlier and to a lesser extent, accelerated depreciation from the office closure. We now expect transformation costs from restructuring and restaurant closures and certain other charges to total between $100 million and $120 million versus our initial estimate of $115 million and $135 million, again, with most hitting in 2018.

So, far this year, we've charged nearly $70 million, and we estimate that another $10 million to $25 million will hit in Q4. And the remaining charges mostly related to terminating restaurant and office leases will still end in 2019. We'll continue to provide specifics on future transformation related costs when we have more certainty around timing and we'll break out the unusual costs for normal costs you can follow the underlying trends.

Our pre-tax income was $50.5 million, and reported effective tax rate was 36.8%. Our 36.8% recorded effective tax rate was higher than our 29.9% underlying rate due to the transformation costs and non-cash tax items related to the write-off of deferred tax assets associated with the underwater option. While we anticipate the underlying rate in Q4 to remain in the 28.9% to 29.9% range, we anticipate our effective Q4 tax rate to be in the high 30% range or higher through the impact of transformation changes as well as anticipated additional non-cash tax write-offs.

During the quarter, we repurchased $19 million of our stock at an average price of $474 per share, leaving about $100 million in our current buyback authorization. Our buyback rate will remain at this lower level, as we fund the transformation cost. This decrease is short term, and we expect to return opportunistically repurchasing shares at a higher level once we've completed the restructuring.

We're encouraged by our third quarter results, as our team has demonstrated that they can stay focused on serving our guests and executing growth drivers, while also being nimble on managing the business. Meanwhile, our support center made important progress in relocating and hiring talent, hosting our All Managers' Conference, and rebuilding an organizational structure designed to innovate and deliver on commitments to our guests, to our employees, and to our shareholders.

And now, we're happy to take your questions.

[Operator]

We will now being the question-and-answer session. The first question will come from David Tarantino of Baird. Please go ahead.

[David E. Tarantino, Robert W. Baird & Co., Inc.]

Hi. Good afternoon. Just a couple of questions on the comp trend. First, Brian or Jack, could you maybe talk about your estimate of the impact, if there was any, from the Ohio incident that was pretty well publicized? And I guess based on how you look at the business looking at maybe your average daily sales trend and seasonally adjust for that, do you think this most recent uplift from the marketing program has got you back on trend, if there was an impact in Q3? And then I have a couple follow-ups.

[John R. Hartung, Chipotle Mexican Grill, Inc.]

Yeah, David, this is Jack. There was a lot going on in the quarter. We compared in the middle of the quarter to some soft results from last year. We had Avocado Day that turned into a double day, once we broke the internet. We had a back-to-school promotion, then we compared to queso, then we had marketing at the end. So teasing out any single impact was very difficult. That's why I walked through and I wanted to give the comp trends throughout the quarter. The thing that we know for sure is that marketing did have an impact. As we went on air and as customers started seeing the commercials, we did see an improvement in our sales. And I think when I look through the net-net of it, by the time we left the quarter, I don't think there's any lasting impact of anything that happened in Ohio.

[David E. Tarantino, Robert W. Baird & Co., Inc.]

Great. That's helpful, Jack. And then on the quarter to-date, you mentioned up 4% for the comp. I know you're cycling now the mix benefits that you had with the queso. So I guess is traffic now running positive in the quarter-to-date period behind the advertising?

[John R. Hartung, Chipotle Mexican Grill, Inc.]

David, it's right around flattish. When you look at the 4%, we're still carrying a price increase in about a couple thousand restaurants. We'll lap the next wave in November and then the final wave in January. So, I'd call the traffic right around flat.

[David E. Tarantino, Robert W. Baird & Co., Inc.]

Great. And then last question for Brian, you talked a lot about the stage-gate process with some of the menu innovation you're working on. So I guess at a high level, when do you think we'll start seeing some new items added to the menu? And then, if you can maybe share your perspective on what you've learned in adding new items to the menu in this operating model.

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Sure. So yeah, we've got obviously a couple items in the stage-gate process, all in various stages actually, both digital initiatives as well as food initiatives. And I think you're going to see both a digital total system from loyalty to our mobile app to our digital shelves. All those things are in test markets right now. And we're very optimistic about what we're seeing. And we're continuing to learn, and the plan is they will start to touch in 2019, consumers; same thing with a food initiative or two. So, we're still early days, David, but we're learning a lot. We're optimistic about what we're seeing. And we're feeling like this stage-gate process is working, and it's going to set us up to execute with excellence on some of these initiatives coming to market in 2019.

[David E. Tarantino, Robert W. Baird & Co., Inc.]

Sounds great. Thank you.

[Operator]

The next question will come from John Glass of Morgan Stanley. Please go ahead.

[John Glass, Morgan Stanley & Co. LLC]

Thanks very much. There were a couple of operational initiatives, Brian, you talked about either on or offline during the quarter, including throughput seemed like an early opportunity for you, and I think you talked about maybe purchasing, professionalizing that organization. Just some of the operational things that you're taking on, where are you on those, and did they have any impact on the past quarter?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

So, we are early days into both of those, and the good news is, I would say our operational focus, I feel like we're out of the starting blocks with getting our throughput to a higher level than where we've been. But really our focus was, at that All Managers' Conference to get everybody aligned on values so that we're hiring the right people. So that ultimately we can end up with a stable team with the right leaders. And then the other key focus for that meeting was to make sure people understood we're getting back to the throughput excellence, great-tasting food. You do those two things, you end up with great customer hospitality.

And what I love is I feel like we're out of the blocks on all these things. And we should – as we go into 2019, we'll continue to make progress as opposed to just getting started with it in 2019. And the same thing goes for the supply chain leadership. Carlos, actually myself, and Jack, we've already started our visits with some of our key partners, and it's been great to understand the relationships that were started, in some cases, 25 years ago, to some that are relatively new. And the good news is, I think this is an iterative process where there's opportunities for Chipotle and our suppliers to benefit going forward. So I'm very optimistic on both of those fronts, and I feel like a lot of good work has been put in place so that when we walk into 2019, we'll start to see some real tangible benefits.

[John Glass, Morgan Stanley & Co. LLC]

Just one more for me. On the digital sales growth this quarter, which was impressive, are you seeing the operational benefits you hoped? Particularly some of maybe the margin benefits you hoped, utilizing the second make-line? Or is it too early, and you have to get sort of a threshold of volume going through that second make-line to really start to see some of the margin leverage benefit that you might expect?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Yeah, I think it's a little too early on the margin side of it. But one of the things that's been great to see is where we have the digital make-line, where we have our shelves, and you've got, obviously, the customer app everywhere. We're seeing increases in customer satisfaction, and we're continuing to see a higher ticket. And it's playing across all those digital channels that you would expect, the app, the web, and in delivery.

[John Glass, Morgan Stanley & Co. LLC]

Thank you.

[Operator]

The next question will come from Nicole Miller of Piper Jaffray. Please go ahead.

[Nicole M. Miller Regan, Piper Jaffray & Co.]

Thank you. Good afternoon. It seems to me you've had – or you're in the midst of a headquarter cultural reset in combination with what is store alignment that could be very powerful. So I'm curious, what are today's store-level incentive metrics? And I've noticed on some of my visits some customer contacts in the dining room, and I'm wondering if that's a particular element that you're focusing on?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Yeah, absolutely. We are very much focused on, we want people to walk away from Chipotle with a top guest experience. I think you heard me mention this. When we say the line is the moment of truth, we believe the whole stage is set from the second you see our line. And those are both digital lines, as well as our customer-facing lines. And I think what Scott and his team have been also focused on is we've got to make sure our hospitality matches that line experience. So, you will see some table touches. You'll see what Scott calls his four cornerstones start to roll out across the system. So, I'm delighted to hear that you're seeing that first-hand.

[Nicole M. Miller Regan, Piper Jaffray & Co.]

And could you speak more specifically about the incentive metrics for the store-level employees?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Sure. We can talk a bit more about that. Scott, I don't know if you want to chime in here, but this is all based on our restaurant AB (27:31) scorecard. So why don't you take that?

[Scott Boatwright, Chipotle Mexican Grill, Inc.]

Hi, Nicole. Good to hear from you. Scott here. Yeah, so our incentives currently are tied to our AB (27:38) scorecard, which encompasses sales and profits, obviously, but also incorporates the guest experience, food safety obviously being paramount to our business. So when we ladder that up, we understand where we are from a business unit perspective. And everyone's striving to reach the A level. We've made great progress this year of getting there. So hopefully that answers your question around incentives specifically.

[Nicole M. Miller Regan, Piper Jaffray & Co.]

That's very helpful. And just a last question. Brian, when you first talked to us a couple conference calls ago, you talked a lot about enhancing and aiding the Chipotle awareness. And today I heard you talk about customers wanting accessibility. So could you compare and contrast those opportunities? And how are you approaching and prioritizing the strategies and tactics between those two opportunities?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

I think you have picked up on what I think are the two biggest levers outside of our operational excellence, around throughput and great hospitality. I think what you just saw with the 'For Real' marketing campaign – and this is what meant by being more visible, and also being more focused on what makes Chipotle unique, different. So you're going to continue to see us push very hard on getting across what makes Chipotle different, what makes Chipotle driving food culture. And then obviously, we want our marketing to be driving the purchase as well. And I think that can be done at the brand level, which is very exciting for Chipotle. Because I think our purpose is powerful.

The other big lever for us is access, and I think it's going to be driven by this digital access. So, those are two things that we are very focused on getting front-and-center. And then obviously, I think there are opportunities for menu variety and a few other things that we talked about. But probably the two biggest focus areas here in the very near-term are the visibility of the Chipotle brand and purpose. Because I think we're creating a new category with folks, and changing food culture. And when we're much more visible with it, customers respond. And then the digital access aspect is another place where we're seeing great response across that whole digital system that we're rolling out.

[Nicole M. Miller Regan, Piper Jaffray & Co.]

So is it fair maybe for us to think about awareness is really generating the call to action, and the access is just reducing the friction to get to you? Is that right?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Well said. I should have started there.

[Nicole M. Miller Regan, Piper Jaffray & Co.]

Thank you for your time, appreciate it. Congratulations.

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Thank you.

[Operator]

The next question will come from Sara Senatore of Bernstein. Please go ahead.

[Sara Harkavy Senatore, Sanford C. Bernstein & Co. LLC]

Thank you. I got two follow-ups. One is just on traffic. I think in the past we've heard there's been a bit of a struggle with frequency, in the sense of just all tiers of customers maybe coming a little bit less. And I was wondering if you could talk about what you're seeing there? Is this where loyalty comes in? Or is it the new menu items that'll bring people back more frequently? So besides access, what are customers telling you that they want to see most, in order to ramp up that frequency curve, which used to be such a tailwind to Chipotle comps? And then I'll have another one.

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Sure. So, yes, what we've seen – and this is early days – is with our loyalty pilot, we're seeing people that have less frequency entering the program. And we don't have enough time to truly understand what ultimately is going to be the impact on their frequency. But we're very excited about the cohort that we're seeing come into the loyalty program in the early days. So we think that is going to play out where that program will be a key vehicle for driving frequency among key cohorts that today have an opportunity to increase the frequency. The other thing that's been really exciting is a lot of our digital business is attracting new and lapsed users to our business. So that's been another real exciting learning for us. Then I think your point on what about the people that historically were coming all the time? I think that's where we need to get back to talking about what makes Chipotle unique in culture, specifically food culture, what makes our purpose so different. Because that really resonates with our heavy users that are bought in. And we've seen some early indications that that's a great way to drive frequency into our loyalists.

[Sara Harkavy Senatore, Sanford C. Bernstein & Co. LLC]

Thank you, that's helpful. And then just on the unit, you were sort of at the low-end of the range this year, but obviously will be above that in fiscal 2019, according to guidance. I'm just trying to understand the extent to which this year's build rate was maybe a function of re-establishing your growth pipeline or your development, how you approach it, versus just the how many attractive trade areas are left? And next year, I guess, would we expect to see more of a mix shift towards some of the newer, less established? Or are you going to continue to mostly focus on these established markets?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

I'll answer and then I'll let Jack chime in as well. But yeah, look, what we're really excited about is the restaurants that we opened this year opened very strong. And the economics support continuing to open Chipotle restaurants above the rate at which we opened this year. And I think that was the guidance we just shared with you all. The thing that's also exciting about Chipotle is we're finding we're having success in some new formats. As I mentioned in the earlier statements, the digital pick-up lane is a very exciting proposition. We're going to do more of those next year. We're also very excited about how we're seeing success in proven markets, and the new markets that we tapped the brakes on, frankly, a while ago. But the economic model of new restaurant openings is very powerful. And as such, we're building the pipeline accordingly, so that where the opportunities present itself, we can take advantage of those. Jack, I don't know if you want to add anything.

[John R. Hartung, Chipotle Mexican Grill, Inc.]

Yeah. The only thing, Brian, I would add is, Sara, we did increase the quality this year, and that showed. We've got better economics this year than we have in the past few. We were more discerning. We were more selective. We did focus more of our attention in the proven and fully-developed markets. But we also had great success in some of the new and developing. So I think by being discerning, both in our proven markets and our developing and new markets, we've got better quality. I think that sets the table now, for us to take this stairstep up that we talked about next year. And I fully expect if we continue to build this kind of quality, we'll look for another stairstep the year after. So we focus on quality first and then quantity second.

[Sara Harkavy Senatore, Sanford C. Bernstein & Co. LLC]

Great. Thank you very much, very helpful.

[Operator]

The next question will come from Andy Barish of Jefferies. Please go ahead.

[Andrew Marc Barish, Jefferies LLC]

Hi, good afternoon. Just wondering if you could – I know you've probably given us a bunch of thoughts coming out of your consumer research, but more importantly, on pricing for next year, any initial conclusions on how you're going to approach pricing versus the historical practice of a larger price increase every several years?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

I'll let Jack – go ahead, Jack.

[John R. Hartung, Chipotle Mexican Grill, Inc.]

Yeah, Andy, we have mentioned on previous calls, we're open to a whole different approach. We're in the early stages of talking to some outside parties about our menu compared to competition, customers that shop within our menu, and are there opportunities? I think you'll more likely see us take smaller price increases rather than wait two or three years or so and then take a larger one, but nothing to report right now.

[Andrew Marc Barish, Jefferies LLC]

Okay. And then just a quick follow-up on again, looking out to next year, having 'For Real' for the full year, how do you anticipate the marketing windows to fall versus, obviously, the late roll this year?

[John R. Hartung, Chipotle Mexican Grill, Inc.]

Yeah. So we are still in the planning phases on exactly when and where we want to use national media. But what we feel really good about is we believe we've got the right communication, and now we're working through how we use the right communication vehicles at the right time. But what we do know is we'll have an always-on social, mobile, digital effort. And then we're still working through how we use the traditional mediums throughout the year in 2019.

[Andrew Marc Barish, Jefferies LLC]

Thank you.

[John R. Hartung, Chipotle Mexican Grill, Inc.]

Yeah.

[Operator]

The next question comes from Sharon Zackfia of William Blair. Please go ahead.

[Sharon Zackfia, William Blair & Co. LLC]

Hi. Good afternoon. I guess just a follow-up to Andy's questions. 3% for marketing, how are you arriving at that as the right number? And how do we think about that going into 2019?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Yeah. So we believe 3% is the right number based on what our planning process is sharing with us. We're using our stage-gate process to really understand what does each initiative provide, as far as growth goes, layered on top of our throughput effort. And what we've seen is as of right now, as we re-approach the marketing budget, we're going to change the allocation from a lot of local marketing to more national. And in that switch, it changes the level of visibility that we can achieve with our marketing dollar. What should happen is, our 3% should feel like we're much bigger than what our 3% has been historically. And that's our ingoing assumption. Obviously if we find, through our stage-gate process, that we have an opportunity to enhance the marketing, because the result matches the increased investment, then we'll do that opportunistically. But the going-in plan is to make more out of the 3% than we have in the past.

[Sharon Zackfia, William Blair & Co. LLC]

Can I ask just a quick follow-up? For your 2018, what percent of that marketing budget is digital?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Chris? Do you know that off the top of your head?

[Christopher Brandt, Chipotle Mexican Grill, Inc.]

I don't know the answer off the top. And I don't know that we necessarily want to give everybody a clue into that. But clearly, with our consumer base skewing more millennial and more Gen Z, that digital is an integral part of the program for us. And one of the things we have a lot of things going on with stage-gate, in terms of five initiatives. But even the media that we're running, we're constantly in a state of where we look at how it goes and how we evaluate it, and how it moves the business. And we'll feel free to shift things between more traditional linear media and digital media as the results warrant.

[Sharon Zackfia, William Blair & Co. LLC]

Okay. Thank you.

[Operator]

The next question will come from David Palmer of RBC Capital Markets. Please go ahead.

[David Palmer, RBC Capital Markets LLC]

Thanks, a couple follow-ups for me as well. You talked about operations, digital menu innovation, and obviously you've done a lot of research and testing. But if you were to rank your biggest bucket or buckets of opportunity from this point, how would you do that, in terms of what is going to be the biggest source of improvement? I think the assumption might be new menu news being the unlock from here, but wanted to hear your thoughts.

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Yeah, look, I don't think new menu news is the primary unlock. I think it plays a role. But I think the digital access, removing friction, and getting into digital access is a big unlock for the Chipotle business. Throughput, reclaiming our throughput capability is another big unlock. And then obviously, I think making the brand more visible and more resonant with this 'For Real' campaign is another unlock. So menu will play a role. But I think you're going to find digital and the combination of throughput, and reminding people why they love Chipotle are going to be big unlocks.

[David Palmer, RBC Capital Markets LLC]

And Jack, in the past, you've had these rules of thumbs about margins, restaurant-level margins, and their commensurate level of sales per unit. How has your thinking been changing on that? Obviously you see innovation in delivery or things that bring complexity, and you think that could be margin dilutive. And on the other side, you've talked about productivity. And of course, there's labor inflation and pricing. Have you really shifted how you think about what margins are possible at what levels of sales?

[John R. Hartung, Chipotle Mexican Grill, Inc.]

No, David, we go through and study this carefully. I think everything with digital, with delivery, we feel good that any time there's an added cost, that there's an opportunity for inefficiency there. So I still think when we get to $2.1 million, we can be in the 21% margin. $2.2 million is a 22% margin. Wage inflation is a bit of a wildcard. We can't overcome that with transaction growth alone. That will require some careful timing and place in a menu price increase. But if we can (41:57) well-thought-out menu price increases to make sure that we manage labor inflation, the model is still intact. And there's efficiencies of moving our customers from the front line to the second make-line. And then it's a matter of working with our delivery partners to make sure that the economics work for both us and them. But everything I've said in the past, David, still intact.

[David Palmer, RBC Capital Markets LLC]

Thank you.

[Operator]

The next question will come from Karen Holthouse of Goldman Sachs. Please go ahead.

[Karen Holthouse, Goldman Sachs & Co. LLC]

Hi. Thanks for taking the question. Two quick housekeeping questions and I have another one. What was the actual cost to the manager conference in the quarter? And what are you looking for first stock comp for the year?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

What was the numbers for the conference?

[John R. Hartung, Chipotle Mexican Grill, Inc.]

It was like, $10 million in the quarter, $11 million for the year. Stock comp for the year is in the – between $60 million and $65 million.

[Karen Holthouse, Goldman Sachs & Co. LLC]

And then, as we've started to see some of the marketing digital initiatives take hold, is there anything you're seeing, in terms of regional variations, in the comp performance? And what I'm really getting at are markets that might be thought of as having more competition in the overall fast-casual space, and specifically with concepts that share a lot of the same philosophies and values around food quality and sourcing. Are those regions keeping pace with the system?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Yeah. We're not seeing big variations in performance based on the initiatives that we've rolled out to date. When we've done our stage-gate process, we've tried to be true to representing the full United States, so we get a picture of how this performs across the country. So no, we've not seen that issue.

[Karen Holthouse, Goldman Sachs & Co. LLC]

Great. Thank you.

[Operator]

The next question will come from Matt McGinley of Evercore ISI. Please go ahead.

[Matthew Robert McGinley, Evercore ISI]

Thank you. On the labor rate in the quarter, you did a good job of managing that relative to what you had anticipated, or told us what it would be in July. What improved relative to what you had assumed back in July?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

I missed the first part of your question. Sorry, you cut out.

[Matthew Robert McGinley, Evercore ISI]

The labor rate looked a little better than you had guided in July, and I'm curious what came in better than what you had anticipated, from a labor standpoint?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Yeah, two things. Our teams worked really hard to manage workers comp and workers comp is something that you don't see the benefit week-by-week or month-by-month. But we saw steady progress throughout the year, and so we were able to make an adjustment there. And then secondly, Scott and the team, they challenged the team during the third quarter to really take a close look at staffing and making sure you got the right people throughout the day. And so we saw some efficiency gained throughout the quarter as well. So those are the two things. And I agree with you that we did a nicer job with labor in the third quarter than we did in the second quarter.

[Matthew Robert McGinley, Evercore ISI]

In the quarter, you ran a few offers to grow digital usage. I think you ran a BOGO and you had the free delivery offer. Did that have any impact on the margin? And is promotion something that you would use on a go-forward basis to drive utilization of that? Or would you expect it to be more of just a more natural increase in digital usages as awareness of the platform builds?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Let me answer the latter part of the question, then I can hand it back to Jack on your margin question. Yeah, what we have seen is when we increase awareness of the digital platforms, we get a good response. And I think over time, our loyalty program and using analytics to inform how we incentivize behaviors is going be the future. You'll see us continue to use what I would call broad scale incentives as we build the database and get people into our loyalty program, get people using the mobile app. But where we're ultimately headed is we want – I think we're less than 50% awareness on these digital platforms. We need to improve that dramatically. And then once we get them into the platform, we need to create a capability around using analytics to drive the right incentives for the right cohort at the right time. So with that approach, we think good things happen throughout the entire P&L. But Jack, I don't know if you want to add anything else.

[John R. Hartung, Chipotle Mexican Grill, Inc.]

Yeah. Listen, I think that was well said. Yes, it does have a theoretical impact on our margin. We give away guacamole. Guacamole, our customers love it. It comes with more than 50% of our transactions. And we gave away a lot of it that we planned on giving it away for one day. We gave it away for two days. But not anything that I would call out when you look at $1.2 billion in sales over the entire quarter. It wasn't material enough to look at. But it's an investment worth making, because we attracted a lot of people into our digital platform, and so it's an investment that will pay off. So it has a theoretical impact on the margin, but not enough to call out during the quarter.

[Matthew Robert McGinley, Evercore ISI]

Okay, thank you.

[Operator]

The next question will come from Jeffrey Bernstein of Barclays. Please go ahead.

[Jeffrey A. Bernstein, Barclays Capital, Inc.]

Great, thank you very much. Two questions. One, just following up on the unit growth discussion. Clearly, you're upping the absolute number in 2019. I'm just wondering how you actually arrive at that absolute number? You talked about how there's lots of opportunities and different types of stores that you could do. I know a few years back you were doing well north of 200 stores a year. So I'm wondering how do you think about, maybe what are the guardrails or challenges to a greater stairstep in growth? I don't know if you think there's certain markets that are at saturation, or is it real-estate availability, or cost to build or quality of managers? I'm just wondering what keeps you from ramping up that number more meaningfully in the short-term?

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Look I think one of the things that always have to go hand in hand with new restaurants is having managers ready to take over those new restaurants. So you have to take it at a measured pace as we increase year to year. Because the last thing you want to be doing is opening restaurants ahead of your capability to run them.

The good news is, I think our economic model suggests we still have room to grow in a meaningful way. And the Chipotle employee value proposition is very compelling. So we're able to attract managers, apprentices, to get them prepared and developed so that they can be part of the growth story as well. So it's really that balancing act if you got to have the teams ready to work and lead the restaurant, coupled with making sure you've got the right economic sites available to open it in. You can't just all of a sudden – well, you could, but we're not going to just go guardrail to guardrail on this thing. I think we would find ourselves not executing very well. So those are the principles we're using.

[Jeffrey A. Bernstein, Barclays Capital, Inc.]

Got it. And then you mentioned the unlocks earlier, which I thought was interesting. You didn't mention anything about, I guess, maybe extended store hours. I know there was some talk of selling burritos earlier in the day or going into breakfast store. I know certain markets you're now doing more late-night initiatives. I'm just wondering how you assess what extended hours might work, what might not work, and the potential opportunity.

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Yeah. I think one of things we learned through the stage-gate process is ours is going to be a surgical approach. It's not a blunt initiative. And so I'm delighted that we learned that in pilots, as opposed to on a national level. You'll see our hours be very surgical. Where it makes sense, you'll see us have some different hours. But it's not going to be a national, blunt effort.

[Jeffrey A. Bernstein, Barclays Capital, Inc.]

Understood. Thank you.

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Sure.

[Operator]

This concludes our question-and-answer session. I would now like to turn the conference back over to Brian Niccol for any closing remarks.

[Brian R. Niccol, Chipotle Mexican Grill, Inc.]

Okay. Thanks, everybody, for listening and joining in. I think as I said in my earlier remarks, very proud of what this team has accomplished in the third quarter. I do believe our strategy to win today and cultivate the future is making tremendous progress. The team that we're building in the support center, I am very excited about diversity of the talent and the caliber of the talent.

I'm also very excited about how we've moved all these initiatives forward while moving the company to a new cultural space through this relocation and restructuring. So the Chipotle brand continues to be a purpose-driven brand that we continue to learn, over and over again, means a lot to our customers, means a lot to our team members, and very proud of what we accomplished to date, and also very optimistic about the pipeline that we're building and the initiatives that we're focused on going forward. So, thank you for taking the time. And I look forward to speaking with all of you in the future. Take care.

[Operator]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.